It shouldn’t come as a huge surprise, but getting a business acquisition loan is a somewhat lengthier and more involved process compared to other types of financing. Your lender needs to evaluate more than just you; they also need to assess the business you plan on buying. At First Bank of the Lake, we also always recommend consulting with professional advisors early in the process such as an attorney or CPA.
With that in mind, having some of these items prepared in advance can help your lender deliver a faster, more reliable loan decision. We have put together a quick list of items to consider early in the process. This is not an official or comprehensive list, but it covers some of the most important and time-sensitive items needed in the loan process, meaning that you can get a quicker loan approval and close your loan faster.
Letter of Intent (LOI) or Purchase Agreement
The Letter of Intent (LOI) is often used initially in a business purchase transaction to begin the due diligence process and lay out the basic terms of the deal in preliminary form. Once due diligence is satisfactorily completed, a formal purchase contract is typically executed with a closing date and other specific terms of purchase and sale. Sometimes parties may skip the LOI and go straight to the contract which is perfectly acceptable. The lender will need to see at least an LOI to move forward with developing a financing proposal.
There are multiple considerations in the purchase agreement that should be addressed, and the key items from the lender’s standpoint are highlighted below.
- Who will get the accounts receivable (A/R)? Accounts receivable is a negotiable item and can go to either the seller or buyer. If the seller gets the A/R, the buyer will have to consider additional working capital to cover the “gap” until new receivables start providing cashflow to the business. A lender can consider permanent working capital in the loan to assist with this gap financing. If the buyer receives the A/R, then the amount of additional working capital is typically reduced. Your loan officer will work with you to determine the right amount of working capital needed for your situation.
- Are there any key employee(s) to retain under an employment agreement? Key employees are typically individuals who have been with the company for a while and hold senior or executive-level positions such as general manager, operations manager, CFO, or other persons unique to that business type. Key employees are often retained under an employment agreement (formal or informal) since those employees play a crucial role in the success of the business. Their experience, intimate knowledge of the business and their relationships with customers or the community make them an important part of the transaction. Remember with SBA loans, if the current owner is selling 100% of the business, they cannot be employees after closing. However, they can work with you under a 1099, or as a consultant for up to 12 months.
- What are the terms of the non-compete? Non-compete agreements are often overlooked in the initial contract or LOI but eventually find their way into the final version under the advice of the buyer’s counsel or lender’s guidance for the loan. A formal non-compete agreement is important to have in any case since the seller will likely have a good bit of cash after closing and may be tempted to start up a competitor business to the one you just purchased.
- Will the seller help transition the business via a consulting agreement? Under the rules for SBA lending, the seller is allowed to assist with the transition of the business operations for a period of up to 12 months. Depending on the type of business and buyer’s experience, this can be an important part of the transition process.
- Does the business you plan to acquire require licenses or permits to operate? If so, the lender will want to know early in the process what your plan for handling the licensure of the business will be and that will also be addressed in your business plan. More often than not, trade or other licensure is required for the smooth and continuous operation of the business. While in many cases the buyer does not have to have the licensure at closing, a suitable arrangement thru a key employee, or the sellers (under a consulting agreement), or other licensure transition plan is going to be required to get the loan closed. States have differing requirements as to who can hold the licensure, so a conversation with an experienced attorney or business broker is important.
- What are the terms of the seller's note? It is common practice to see the seller provide a piece of the financing in the form of a seller note. While not a requirement of the SBA loan, seller notes are desirable from the lender’s viewpoint since the seller continues to have an interest in the success of the business after closing. The seller note typically includes a reasonable rate of interest, and matching amortization to the loan term which is 10 years for business acquisition financing.
Business Plan
Buyers must provide the lender with a business plan for the business they are acquiring. The business plan and financial projections are not just meant to check a box in the needs list, rather lenders want to see that you have a clear understanding of the business you are buying and a reasonable plan for moving forward. It is usually good to include ways that you plan to improve the business where you see fit, your plan for the transition of ownership, and how you plan to grow the business. There are many resources for developing an effective and useful business plan, and your loan officer should be able to recommend their preferred resources for developing a plan that is for the purposes of your loan.
Life Insurance
If you need to secure life insurance for yourself as is typically the case with business acquisition loans, begin the process immediately. Getting coverage can sometimes take longer than you anticipate and can delay your closing if not done in advance. If possible, use a provider experienced with coverage for SBA loans. As the life insurance will be collaterally assigned to your lender, your lender should be able to refer you to providers that will satisfy this requirement of the loan. Consider that if anything happens to you, it’s vital to your family’s financial well-being that your SBA loan be paid off.
Property Lease
If a buyer intends to continue leasing the property occupied by the business being acquired, your lender will need a copy of the seller’s current property lease. In some cases, the lease is assumable. In other cases, some renegotiation may take place. The initial lease term, plus any renewal options, must be for a minimum term equal to the loan amortization. For example, a loan term of 10 years, which is standard for an SBA business acquisition loan, would call for a 10-year lease including any renewal options. Sometimes a little negotiation to allow for renewal options is needed to get to the 10 years. A good business broker can assist in this process, and your loan officer can guide you as well.
Landlord Waiver(s)
If you are leasing space for your business, your lender will require the completion of a landlord waiver. Since the lender will have a lien on your assets located within the leased space, they will ask for the landlord to execute a waiver that allows the lender to have access to the premises. Ask your lender for the waiver and provide it to the landlord as soon as possible. Finalizing the landlord waiver is a part of the process which can affect how quickly (or slowly) your loan closes, so we always recommend this be addressed early in the process.
Business Valuation
To better understand the seller’s pricing, you may be asked to provide documentation supporting the factors that contributed to your offer price and why you think the price is appropriate for the business. A good business broker can assist with this. The lender will order the business appraisal on your behalf once the financing proposal has been executed, and that will be the basis for the valuation of the business for the SBA loan. The majority of businesses are valued based on multiples of EBITDA or some derivative thereof, and as mentioned above, a good business broker can often assist in this initial determination mentioned. Additional value considerations may include looking at the selling prices of recently sold comparable businesses, business size, industry, historical growth, recurring revenue, revenue trends, financial projections, and customer concentrations and types.
Other Helpful Considerations…
- Equity Injection or Down Payment – Equity injection is the amount of your personal cash or assets you contribute towards the total project cost at closing. Prior to closing, you will have contributed some of this equity in the form of escrow deposits to the lender used for certain expenses such as the business appraisal. This and other eligible expenditures can be counted toward the overall equity down payment at closing.
- Title Insurance – If commercial real estate ownership is part of the transaction, then you will need title insurance to close your loan. It is not unusual for surprises to pop-up with a title when the searches are done. While these surprises are often easy to fix, they can take time, so it’s best that the process of title insurance be addressed. Your lender’s closing advisor will often join in the loan process early to help with communication and planning for the eventual closing. This proactive type of banking often reduces friction and helps make for a smoother overall process.
- Business Insurance – If you are buying a business, you need commercial insurance. In addition to the life insurance mentioned above, your lender will require general liability, professional liability, business personal property, business income, and workers comp coverages shown on the certificate of insurance, with the lender added as an additional insured, lender's loss payee and certificate holder. Please provide your commercial insurance agent contact details as soon as possible and your lender will reach out to them to share the requirements. Note that the insurance for your business must be bound and in force at the time of or just prior to the loan closing.
- Earn-outs – Another key item to remember is that SBA does not allow “earn-outs.” In other words, the price cannot be altered after closing based on performance, for example. While there are possible alternatives to earn-outs that do not affect the purchase price, those will need to be reviewed by the lender for SBA compliance.
Not all lenders are created equal. An SBA Preferred Lender can help borrowers get the funds they need faster than a regular SBA lender. When a bank or financial institution has a “Preferred Lender” status, they have the authority to make final credit decisions on SBA-guaranteed loans. By contrast, non-preferred lenders must submit the loans directly to the SBA for approval, which makes the process longer.
As a nationwide SBA Preferred Lender, First Bank of the Lake has the resources and extensive experience needed to tailor solutions for your business and guide you down the path to success. Lending decisions are driven by our team of banking professionals who understand your business. We employ our creativity, understanding, experience and expertise to build the right solution for you.
Let us show you how First Bank of the Lake can help get your deal to the closing table.